~ Investment Strategy

Macro Diary

Has a turning point been reached in US real interest rates? They have moved upwards since the Fed’s change in its forward guidance in December, which is consistent with my view that the change represented a moderate tightening of policy. If the economy continues to improve then monetary conditions will tighten automatically thanks to the Fed’s new language — which means that the answer could be “yes”. Real interest rates may have seen their lows. If that turns out to have been the case, then we may also have seen the top in gold, which is closely related to real rates.

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It is always interesting to read something that is obvious when you think about it. Here is one such thing that I read this morning: the decline in China’s working-age population is likely to continue, and that means that a slower rate of GDP growth than would otherwise have been required will be necessary to prevent mass unemployment. Holding the rate of migration constant (I do not know of any reason to expect it to accelerate sharply), that means that China’s GDP will be able to grow more slowing in the future than it has in the recent past without causing unrest. From the point of view of the Chinese authorities, therefore, there is room to allow the economy to grow more slowly, in order to control inflation (the big cause of unrest); hence, a strong stimulus should not be expected while GDP growth remains relatively strong.

Of course, one has to establish what “relatively strong” means. But since growth of about 8% has not meant a large stimulus so far, it may well be that 8% is considered an acceptable rate of growth by those in power.

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US markets are closed today for Martin Luther King Day, but debate about the debt ceiling rumbles on. A vote is planned in the House for 23rd January, although I am not sure why it has been called. Tim Geithner has written to congress to point out that government cash-flow is erratic in February, which means that there is no guarantee that the bills could actually be paid out of cash flow after various temporary measures are exhausted some time in mid-February.

Also on the political front, the CDU lost in Lower Saxony, in a slight blow to Mrs. Merkel. In fact, the CDU outpolled the SPD by 36% to 32.6%, but the SPD’s coalition partner did a lot better than the CDU’s coalition partner. Thus, Lower Saxony will effectively be governed by the SPD. How anyone can argue that proportional representation is more democratic than first-past-the-post is quite beyond me.

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FT Alphaville has an interesting discussion of the effect that the fiscal-cliff debacle in 2011 had on the repo market. Apparently, some money-market funds are forbidden from holding defaulted securities as collateral for repo lending. Since their systems were not set up to distinguish between defaulted and other securities, they pulled back from repo lending as fiscal-cliff deadline approached. Other funds followed suit. There is speculation that this effect could begin earlier in the current episode, because it is now well-known.

Also, there is an issue that money-market funds often include a put-option in their repo lending that allows them to unwind it early with seven days’ notice (this is to allow longer-term repos to be classified as liquid investments). These options are normally not used except when a fund experiences large outflows, but they are there. It is possible, if there is another fiscal-cliff debacle, that banks that thought they had funding for a reasonably long period could find their repo loans withdrawn.